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Yes, Debt CAN Be a Great Investment

Don't write off all hole-digging as inherently bad


If you were to ask most members of Generation Y, debt is a four-letter word.

youngInvestorsB.pngIt’s no wonder. National debt breeds lots of alarmist headlines. Mortgages are often associated with the housing crisis. Commercials like this one graced the TV when I was growing up.

Even the American dream of attending college is rarely mentioned without talk of skyrocketing tuition costs and the growing pile of student debt — which just reached $1 trillion — that comes with it.

The resulting assumption of these horror stories — that it’s universally bad to spend more money than you make — seems, at first glance, to be a step forward. It’s better that we recognize debt as “bad” and avoid it rather than pile more and more of it on … right?

But not all debt is created equally. In fact, taking on some type of debt — especially when you’re young — can actually be a savvy move. InvestorPlace Editor Jeff Reeves noted the need for a more nuanced view of debt in a column a couple months ago. The money quote:

“Debt is similar to guns or sleeping pills or Twitter accounts; the virtue of its use varies greatly depending on the intentions of the user.”

Taking on debt (smartly) comes with plenty of perks, he notes, including the fact that it builds your credit score and allows you to make a big purchase while still maintaining a cushion or emergency savings.

Of course, it’s still best to take on debt that actually builds assets.

The most obvious example is the aforementioned college dream (as I’ve noted before). While you have to dig a pretty deep hole for higher education these days, the numbers show that you’ll get it all — and much more — back. The average annual return of a college education is 16%, while studies show college grads make $1 million more in wages during their working lives.

Sure, you should minimize that debt as much as possible … but don’t shy away from it completely.

Another example of a potentially asset-building debt: a mortgage. Although many (including Yale professor and home-price tracker Robert Shiller) think the idea of housing as an investment is a fad, others still believe in its potential.

Considering the eye-popping rise in housing prices during the past few months, it’s easy to see why. Plus, as residential property investment shop director Andrew Jeffery retorted to Shiller’s dismissal of the investment, houses don’t just hold potential for price appreciation, but all real estate also can generate cash flow since you can rent it out.

Taking out a large loan to buy a brand new car, on the other hand, may not be a particularly smart move considering its value will depreciate the second you drive it off the lot. With that in mind, owing a couple hundred thousand for such an asset like a house might actually be a great move to make … especially since you can take that debt out right now with low, low, low interest rates.

Which reminds me: Matthew Yglesias recently had a quick and insightful Slate piece called “You’re Never Too Young To Be Excited About Low Interest Rates!” which makes the case for why young people especially shouldn’t be afraid to pile on a few more IOUs. The reason: something called “consumption smoothing.” As he explains:

“You don’t make much money when you’re young, but your earnings rise as you gain experience and seniority. Then eventually your earnings fall again and you retire. But rather than having your level of consumption take that same up-and-down swing, it makes sense to ‘smooth’ the path of your life cycle consumption. In other words, you go into debt when you’re young and then pay down the debts and build up savings during prime age and then spend down your savings while in retirement.”

Granted, Yglesias doesn’t explicitly separate different kinds of debt in his explanation … but he seems to be mostly making the case for a mortgage considering the interest-rate peg.

Unfortunately, my generation is paring back our debt levels while digging holes in the wrong places. Nearly half of Generation Y’s debt comes from non-asset-building loans, according to a recent study reported by MSN Money, while that figure drops to 40% for Generation X.

That’s worrisome considering a debt hangover from a too-large credit card bill could leave a bad taste in your mouth for any and all lending.

The lesson: You should indeed be smart about just how much you owe as a young’un … but don’t make the mistake of throwing out the asset-building baby with the bad-debt bathwater.

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Article printed from InvestorPlace Media,

©2017 InvestorPlace Media, LLC